Strategic Management Industry Analysis

Sources of Superior Profitability Attractive Industry Superior Profitability Firm Resources & Capabilities

Historical ROE Spreads Across Industries (1976-91) Equity Spread (ROE-Ke) 13 Soft Drinks Ethical Drugs 11 Tobacco mean = - 1 . 3 9 std.dev. = 5 . 7 5 Grocery Stores 3 Publishing Food Wholesalers 1 Integrated Oil Hotels/Gaming Basic Chemicals -1 Packaging & Container -3 Tire & Rubber -5 Auto & Truck Mfg. Metals & Mining -7 Textiles -9 -11 -13 Air Transport -15 Steel Number of Industries -17 Oil Field Services 2 4 6 8 10 12 14 16 18 Source: Marakon Associates, Value Line

Perspectives on Strategic Management Industry Opportunities -Analyze industry structure -Superior product positioning in an attractive industry “Industry Structure” HOW TO BUILD SUSTAINABLE COMPETITIVE ADVANTAGE STRATEGY From readings see that in general two perspectives on what impacts a strategy Industry analysis: Porter Analyze industry structure to see where can position your firm to create advantage What do i need to do well? FRAMEWORK: 5 forces Firm Analysis: (Montgomery) Analyze firm resources and characteristics that provide unique advantages in potentially multiple markets What do I do well, where can I apply it? FRAMEWORK: Firm Capabilities Firm Resources and Capabilities “Firm Capability” -Analyze firm resources -Develop unique resources and capabilities

Bargaining Power of Suppliers Bargaining Power of Buyers “Industry Structure” Perspective “Five Forces” Analysis of Competitive Strategy Bargaining Power of Suppliers Threat of New Entrants Rivalry among Existing Competitors Bargaining Power of Buyers Threat of Substitutes How can we understand the “structure” of an industry and the influence of that structure on firm performance? (Industry structure determines strategy determines performance) Examples: Buyer power (reduce power to appropriate value) brand loyalty (cigarettes, coke), switching costs (software platforms) COUNTER EXAMPLE--ATT-MCI Supplier power (reduce power to appropriate value) multiple sources (dedicated auto industry suppliers, all raw materials are commodities) COUNTER EXAMPLE: Pharmaceuticals (dependent on patented products) Threat of Entrants (create limits on entry) Scale economies (old ATT-natural monopoly), learning effects (semiconductors, chemicals), capital investments (pharmaceutical R&D), proprietary technology , distribution channels (coke vs 7-up at McDonalds) Substitutes (incorporate benefits same “need” satisfied by other products) vacation (skiing vs snorkeling), Rivalry (Avoid excessive rivalry) understand and focus nature of rivalry, anticipate reaction dimensions, price, technology, quality, advertising, line extensions

Barriers to Entry What factors keep potential competitors out? Scale economies e.g., aerospace industry Scope economies e.g., retailing Capital requirements Switching costs e.g., Windows operating system Access to distribution e.g., soft drinks Product Complexity e.g., supercomputers, microprocessors Entry deterring regulations e.g., Tobacco D A B C Industry

Threat of Substitutes What alternatives are available to customers Industry A Direct substitution with the same functionality diesel vs gas engines DirecTV vs cable Eliminating need for product water meters vs flat rate C B D Customers

Nature and Focus of Rivalry Why industries are more or less “competitive”? Factors Industry growth rates Where to secure growth Exit barriers e.g., specialized assets, emotional barriers Fixed costs e.g. capacity increments Lack of product differentiation e.g. differences in functionality, performance Switching costs Industry A C B Competitive rivalry can focus on many factors, including price, quality, technology, features, service, etc.

Supplier or Buyer Power How can my suppliers or customers extract value Supplier Power Supplier concentration Few vs many suppliers Supplier volume Large vs small purchase decisions Product differences Dependence on unique features Threat of forward integration Ability to become competitor Switching costs Limitations on ability to change suppliers Buyer Power Buyer concentration Few vs many customers Volume of purchases Large vs small purchase decisions Available alternative products Competitive products Threat of backward integration Ability to become a competitor Switching costs Threat of switching suppliers

How Industry Structure Influences Profitability Others (>10) (20%) Green Giant (4%%) Percent of Market Others (>1000) (90%) Campbell (17%) Others (>10,000) Swanson (25%) Stouffer (34%) American (2%) ConAgra (1%) Kroger(3%) Safeway (4%)

INDUSTRY COMPETITIVENESS THREAT OF ENTRY HIGH entrants have cost advantages moderate capital requirements little product differentiation deregulation of governmental barriers Example: Airlines INDUSTRY COMPETITIVENESS HIGH many companies little differentiation excess capacity high fixed/variable costs cyclical demand BUYER POWER MEDIUM/HIGH Buyers extremely price sensitive Good access to information Low switching costs SUPPLIER POWER HIGH strong labor unions concentrated aircraft makers THREAT OF SUBSTITUTES MEDIUM Autos/train for short distances Source: J. de la Torre

INDUSTRY COMPETITIVENESS THREAT OF ENTRY LOW economies of scale capital requirements for R&D and clinical trials product differentiation control of distribution channels patent protection Pharmaceuticals Example: INDUSTRY COMPETITIVENESS LOW high concentration product differentiation patent protection steady demand growth no cyclical fluctuations of demand BUYER POWER LOW Physician as buyer: Not price sensitive No bargaining power. (Changing with managed care.) SUPPLIER POWER LOW THREAT OF SUBSTITUTES LOW No substitutes. (Changing as managed care encourages generics.) Source: J. de la Torre

Successful Strategies Should: Minimize buyer power (e.g., build customer loyalty) Offset supplier power (e.g., alternative source(s)) Avoid excessive rivalry (e.g., attack emerging vs entrenched segments) Raise barriers to entry (e.g., make preemptive investments) Reduce the threat of substitution (e.g., incorporate their benefits)